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Limited recourse: Difference between revisions
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So firstly, the [[investment manager]] is an [[agent]]. An [[agent]] isn’t liable ''at all'' for ''any'' of its [[principal]]’s obligations. It is a mere [[intermediary]]: the [[JC]] have waxed long and hard enough about that elsewhere; suffice to say the concept of [[agency]] is one of those things we feel [[Legal concepts all bankers should know|''everyone'' in financial services should know]]; this is not one to drop-kick to your [[legal eagle]]s: it is fundamental to the workings of all finance. | So firstly, the [[investment manager]] is an [[agent]]. An [[agent]] isn’t liable ''at all'' for ''any'' of its [[principal]]’s obligations. It is a mere [[intermediary]]: the [[JC]] have waxed long and hard enough about that elsewhere; suffice to say the concept of [[agency]] is one of those things we feel [[Legal concepts all bankers should know|''everyone'' in financial services should know]]; this is not one to drop-kick to your [[legal eagle]]s: it is fundamental to the workings of all finance. | ||
So why would an agent seek to limit its principal’s liability to the particular pool of assets that principal has allocated to that agent? | So why would an agent seek to limit its principal’s liability to the particular pool of assets that principal has allocated to that agent? | ||
Probably because the [[principal]] has said, “I don’t trust you flash city types, with your [[Sharpe ratio]]s and your [[intelligent beta]]. If I am not careful you could put on some [[Amaranth Advisors LLC|insanely cavalier spread play on the seasonal convergence of natural gas futures]] and blow up my whole fund. I don’t want you to do that. So I am only prepared to risk the assets I give to you, and that is the end of it.” | |||
What the [[principal]] is doing here is ''broadly'' of a piece with segregated, ring-fenced [[repackaging]]. She is saying, “swap dudes: you are trading against, and limited in recourse to, ''this'' bucket of assets. Cut your cloth accordingly.” | |||
The answer likely to come: “Well, [[all our other counterparties have agreed this]].” Alas, in this particular case, the [[agent]] is probably right. | And that would be fine, if it ''were'' like a ring-fenced, repack. But it is not ''quite'': for one thing, poor swap counterparty has no [[Security interest|security]] over the pool. It gets no “quid” for its “quo”. It is ''limited'' to that pool of assets, but it has no ''priority'' over them, as against other general creditors of the fund, as it would if it had security. It may find itself not only limited to the pool of assets but ''even then'' only recovering cents in the dollar on them. ''Double whammy''. You could fix that by having the fund represent that ''all'' other creditors are similarly limited to ''other'' pools of assets, so every creditor has its own dedicated bucket — but that is messy and unreliable. Are there really no other creditors? What about people claiming under a tort?<ref>Okay, I know, I am reaching here a bit. But still, the principle.<ref> Granting security is much cleaner and neater — but you’ll never get it. Somehow, asset managers have won this battle. Swap dealers the world over run this structural risk. One day this might come back to nip them on their bottoms, like an angry [[black swan]]. Who can say? | ||
Note that the [[principal]] — or more likely the [[agent]] — is engaged in some dissembling here. So the principal wants its agent on a short leash. Fine; understood. Fair. But whose problem should ''that'' be? Who should carry the can when an [[asset manager]] exceeds its mandate, goes [[crazy-ape bonkers]], or just, in the vernacular, ''royally fucks up''? Not, we would submit, an arm’s length swap counterparty trading in goo faith, for value and without notice of turpitude. The incentives are all wrong. | |||
The general principles of agency, we submit, say this should, principly, be the [[principal]]’s problem. ''Choose your agents wisely''. If not the [[principal]]’s problem (“I did! I conducted [[due dilly]] and everything! What more could have done?”), then it should be the ''[[agent]]''’s problem. “You, sir, have let down your principal. It is very disappointed, and you must make amends for all this liability you have incurred on its behalf.” | |||
The one person whose problem it should ''not'' be is the poor, weather-beaten old swap counterparty. ''Yet this is what agent-pool recourse limitation does''. It transfers ''[[agent]]'' screw-up risk — perhaps a [[second-loss]] risk, but still a material risk, since you have unreasonably limited the [[first-loss]] to an arbitrary number — to the swap counterparty. It is hard to understand why a swap dealer would ever agree to this. The answer likely to come: “Well, [[all our other counterparties have agreed this]].” Alas, in this particular case, the [[agent]] is probably right. | |||
====The asset pool is indeterminate==== | ====The asset pool is indeterminate==== | ||